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Does vertical integration make sense, particularly when an industry is moving offshore to regions of cheaper labor?

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The make-or-buy question has confounded many executives. To wit, when should a company rely on itself to manufacture or provide certain parts, products or services, and when should it instead purchase them from outside sources? This issue of vertical integration has long been the topic of considerable debate, especially for mature markets like automotive, which leads to a second, related question: How can companies stay competitive when their industry is moving offshore to regions of cheaper labor?

Both subjects were recently investigated by Filipe Santos, assistant professor of entrepreneurship at INSEAD in Paris, Ana Abrunhosa of the faculty of economics at the Universidade de Coimbra and Inês Costa with the Center for Innovation, Technology and Policy Research IN+ at the Instituto Superior Técnico in Lisbon. The researchers studied developments in the Portuguese footwear industry during the 15-year period from 1990 to 2005. That global market has been undergoing dramatic changes. On the supply side, manufacturing has been shifting away from developed regions, such as the United States and southern Europe, and toward emerging economies, including China, India and Eastern Europe. Meanwhile, on the demand side, consumers have been increasingly thinking of shoes as a lifestyle purchase instead of a basic item of consumption. (Details of the study are contained in How to Compete in Mature Industries? Boundary Architecture as a Mechanism for Strategic Renewal, which was a finalist for best paper award at the 2006 Strategic Management Society Conference.)

To study how organizations were dealing with those changes, the researchers conducted in-depth case studies of three companies — Basilius, J. Sampaio & Irmão and Investvar — that were roughly comparable in 1995 in terms of size and business activities but then experienced radically different performance trajectories. Basilius had established an excellent strategic position in 1995 but was performing weakly 10 years later. In contrast, J. Sampaio & Irmão was positioned weakly in 1995 but was performing strongly 10 years later. And Investvar was included in the study as an example of an extreme success — a company with a similar starting position in 1995 but considered by industry experts as the best performer from 1995 to 2004.

For the three companies, the researchers looked at the interconnected set of business activities that created value for each organization.